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SMSFs hit by loss of tax-free status and franking refunds

Analysis on the impact of the legislative changes to superannuation since 1 July 2017 has revealed a massive jump in the amount of tax paid by SMSFs, so much so it should prompt the Labor Party to scrap its proposal to cancel cash refunds for excess dividend imputation credits.

The June 2018 SMSF Benchmark Report by Class (an SMSF software provider) highlights that the Government’s decision to cap the amount of super an individual can hold in pension phase to $1.6 million, along with higher taxes for those people in the transition-to-retirement (TTR) phase, has had a dramatic impact on the SMSF sector.

The Class Report calls this impact “tectonic” and "the tax implications are huge" and I agree 100%.

Introducing the $1.6 million transfer balance cap and changing the tax treatment of TTR streams has meant almost 25% of SMSF assets have lost their tax-free status.

Source: Class Limited

Huge shift in assets out of tax-free pensions

Assuming a modest return of 5% on assets for the 2018 financial year, Class estimates SMSF earnings are generating a tax bill of $3.2 billion, a “whopping” $1.5 billion jump from 2017. Remember, too, this estimate is based on earnings only. The tax outcome of a fund also needs to consider contributions taxes, deductible expenses and rebates including franking credits.

The higher tax bill reflects the huge shift in assets. At June 2018, the asset value in accumulation phase was $422 billion, a 90% increase from March 2017 when it was $222 billion. Another way of painting this picture is to note that in March 2017, 31% of assets were held in pension phase and 45% were held in the mixed phase. As at June 2018, only 14% of assets remain in the tax-free pension phase, while the mixed phase has jumped to 57%.

Inevitably, moving the goal posts will usher in new strategies. On this occasion, there’s been a silver lining; an increase in contribution splitting and recontributions has led to a significant improvement in the gender imbalance in SMSF assets and balances and it will be interesting to see if the trend continues.

Based on this data, Class concludes that pension SMSFs should not be hit again:

“Given the impact of the 2016 super reforms, we don't consider the proposed Labor policy to further increase the tax burden on self-funded retirees by reducing imputation credits for SMSFs is appropriate, especially if it disproportionately impacts SMSFs compared to APRA funds. If the proposed changes go through, SMSFs will not only be subject to 15% income tax on a higher portion of their assets (now in accumulation), but they may also lose their tax credits on their pension and accumulation assets. The system has undergone unprecedented SMSF regulatory changes over the past two years, and we hope the end of the impact of this super reform is now in sight.”

I couldn’t agree more. It’s why the Labor Party should revisit its proposal to cancel cash refunds for excess dividend imputation credits. The arguments why this is not only poor policy but highly inequitable have been well aired.

SMSFs have planned based on franking credit receipts

To begin with, this policy has been well-established for nearly two decades, having been introduced on 1 July 2000. For many SMSFs in retirement phase, it’s a core investment and income strategy.

Calculations by the SMSF Association suggest Labor’s proposal will affect more than one million Australians saving for their retirement. Further, it will cut about $5,000 from the median SMSF retiree earning about $50,000 a year in pension income, equal to a 10% pay cut. As the peak body said, “Arguing these people won’t be paying any more tax is just semantics.”

The fiscal benefits Labor believes it will reap are unlikely to eventuate, especially in wake of the 1 July 2017 changes. Changes of this magnitude always have unintended consequences. Expect SMSFs, especially those paying income streams, to seek other sources of yield, potentially from higher risk assets. In retirement, capital security is critical, yet the chase for yield (income) could jeopardise this for some retirees.

Alternatively, less attractive after-tax returns on domestic companies could presage a shift to foreign companies, with ramifications for blue-chip ASX-listed companies where SMSFs have provided much-needed ballast for their shares prices.

There’s a more fundamental issue to be addressed. When Labor introduced compulsory superannuation in 1992, the goal was to encourage people to be self-sufficient in retirement. And SMSFs have taken Labor at their word. They have used the system governments have devised to be financially independent in retirement and off the government pension.

But Labor is now seeing SMSFs as a cash cow, a retirement savings vehicle for the wealthy, to be tapped to meet more immediate fiscal needs. It reflects an attitude of all governments that the superannuation honey pot that has now reached $2.6 trillion is there to be tapped for any policy that typically only has political merit.

All governments need to remember the sole purpose of superannuation is to give people financial independence in retirement. If changes need to be made, then it should only be after long and considered debate outside the budget cycle.

 

Olivia Long is Managing Director, Strategy & Operations at Prime Financial. This article is general information and does not consider the circumstances of any individual.

 

14 Comments
Judith White
February 21, 2019

Well said Paul!

john smith
August 19, 2018

At June 2018, the asset value in accumulation phase was $422 billion, a 90% increase from March 2017 when it was $222 billion.

Assuming rational behaviour then what this really means is that :
1. there was $200 billion that was forced to be moved back to a taxable position within the Super system.
2. that $200 billion should be equal in total to TRIS plus amounts in excess of $1.6 million.

eventually the Govt. of the day will also tax all pension funds at 15% as spending outpaces revenue.

john smith
August 19, 2018

if I was a politician looking for $$ to buy votes to get into power. what do I do assuming I did not give a !!#$ about the long term future of the country ?

1. increase taxes on the minority 'rich people' and companies. there are fewer votes her c.f. the welfare beneficiaries.

2. suck up to and spend up on the biggest group of voters. more that 1/2 the voters are net govt. welfare beneficiaries. we want this one to vote for me.

3. distract and confuse voters with side issues like Green issues, climate change, immigration, political correctness etc.

I should be a politician !

SMSF Trustee
August 18, 2018

OK. I missed that one. Apologies Alan. But it’s a new argument!
If that’s the principle then it should apply to all policies affecting investments.
So presumably they’ll repeal the $1.6 mn limit for those who made their retirement investment decisions prior to that change? Yes, didn’t think so.

Graham Hand
August 17, 2018

Hi Alan and SMSF Trustee, yes Alan is right, this is what Chris Bowen said at the National Press Club on 17 May 2018:

Journalist: "Your negative gearing changes are grandfathered meaning those who enjoy the benefits today enjoy the benefits forever; they're largely baby boomers who enjoyed the growing economy every step of the way from free education all the way through to negative gearing with you. How is that fair?"

Bowen: "It's fair because those people have made investment decisions based on the rules at the time. Big investment decisions and we respect that."

Alan
August 17, 2018

SMSF Trustee
I read this in a reply from a cufflink document from another person, who asked one of the Labour ministers a number of questions. I assume that one of the questions related to why negative gearing of houses as to be allowed. The answer supplied in the article was that this was the law at the time, as was the return of franking credits to investors - this is in my opinion an inconsistent approach - both issues were lawful at the time, so both should still apply for existing users or neither.
I can only assume that the answer provided in the article was an accurate representation of the ministers reply. Changing laws retrospectively does not seem fair, perhaps even un-Australian.
I don't see any reason why house prices shouldn't fall, they are inflated after all. A controlled steady reduction would benefit many young Australians, who could enter the market that eludes them currently. I also believe that interest rates will remain low because people cannot afford higher payments, and this would also result in the necessity for house prices to fall??
It seems laws and decisions favour the 'well to do'.
My main concern is that Labour want to 'force' (perhaps too harsh) people into managed super funds, even after there have been so many complaints relating to advisors, lack of services and fees.

SMSF Trustee
August 17, 2018

I've never heard that argument (against the removal of negative gearing) and I've been around the issue in one way or another for 40 years.

It's always about the alleged impact on house prices (they'd fall) and the availability of rental accommodation (it would fall too) or the unfairness of not allowing one particular type of business (providing rental accommodation) to deduct a legitimate expense incurred in operating the business.

So, sorry Alan, I don't think there's an inconsistency argument to be made here.

Alan
August 16, 2018

I am not sure of these circumstances but I have heard that negatively geared housing has been exempt from any change in taxation rules because these rules were in place at the time.
I would like to submit t the labour party that at the same time the return of franking credits to investors was also in place.
How can Labour accept one case and reject the other when both were accepted as law, during the same period? As someone who thinks, I wonder if this has more to with the situation whee none of the politicians are in the SMSF situation but many of them (and friends) may have negatively geared properties. Some of them may even have interest only loans - a gamble that housing prices will rise over the investment period and taxation receipts during this time will exceed the capital gains tax accrued in the same period,
I don't understand why (or how) someone would need (or afford) more than 2 or 3 negatively geared houses.
I would also like Labour to consider the results of the Commission into banks, which 'uncovered' very poor practises in the advice and fees paid to financial advisors, employed by the banks. Do the think that any other financial entity provides a better service? Mine did not. Disclosure of fees, taxation obligation after 60 years of age and fees for 'no' service occurred in my managed super fund. This is the reason why I have entered the SMSF scheme.
Labour is very inconsistent in their view of superannuation providers and the need for negatively geared houses.
Even worse Labour introduced superannuation to reduce the number of people dependent on government pensions.
Why do voters dislike politicians? Read the above again - don't do what is good for all Australians, just what might get us elected.

Matthew Collins
August 16, 2018

If the target of the Labor's proposed changes is to tax members with greater than $1.6 million, I believe it will miss its mark.

Members with balances over $1.6 million will now generate taxable income in their fund. The resulting income tax will be offset by franking credits which they earn. This will potentially mean that there won't be excess franking and their will be no refund to lose.

On the other hand, funds with balances of less than $1.6 million in pension phase will most likely worse off due to the fact that any franking credits they earn will no longer be refunded.

Robert
August 16, 2018

Why do so subscribers like “Ashley” bother to write anything when is obvious they have no idea about the issue? Where is the data to support the assertion that “ only a very small fraction of smsf members or funds have lost their tax free status”? It’s also obvious that you don’t understand the article. Owning a house won’t give you an income stream in retirement. The article is referring to all people with SMSFs irrespective of the amount held,not just people with over $1.6m.

Jane
August 16, 2018

Ashley I can bet you are 20- 30 years too young to be affected by this potential unfair policy by Labour.

For the last 15 + years we were indoctrinated to save & save via the Superannuation system, which a awful lot of us did, as a consequence of this encouragement we provided for our retirement, we are now being threatened by Labour’s incredibly discriminating policy. Some of us fortunate enough to save enough, take risks, but end up not being eligible for any pension, we are extremely concerned that Labour will take away a proportion of our income, the costs of the pension will outweigh the tax gained over a period of 20-30 years. We will change our investments, or cash out & spend to reduce our Super balances.

There will be a lot of very angry self funded retirees if Labour gets the power.

Ashley
August 15, 2018

While it may be true that ‘25% of SMSF assets have lost their tax-free status’ – only a very small fraction of SMSF members or funds have lost their tax-free status. Who cares about the people with more than $1.6m per person (or $3.2m per couple) in super? There are no swinging votes in that. Super is mainly a tax-advantaged vehicle for the rich and lucrative for the industry. Most of the real wealth for Australians is, always has been, and probably always will be – outside super – eg in housing, businesses, etc

Mitch
August 16, 2018

You are VERY OUT OF TOUCH Ashley if you think super is only for the rich. I am by no means rich and my super is all i will have to try and have a reasonable retirement without relying on the pension.

Tamas
August 16, 2018

Ashley, for the facts on Imputation Credits and their reason for being pls read Ex Labor Treasurer Paul Keatings letter in the AFR of August 6 (attached):

Personal tax rate far too high

Your correspondent, Rex Bevan (Letters Friday 3 August) displayed his misunderstanding of the dividend imputation system I introduced in 1987 and what's more, did so under the unlikely heading "Corporate tax system distorted".

Mr Bevan is blandly urging a return to the double taxation of company income – a distortion if ever there was one. A distortion I removed when I allowed company tax, formerly paid, to be stapled to a company's dividend for individual and final taxation purposes. Mr Bevan labels this a tax lurk.

Under this system, the maximum rate of final taxation in the hands of the taxpayer on company income is 47 per cent. Under a system Mr Bevan urges, the rate of final taxation would be 63 per cent. And somehow, he thinks this would be an advance.

In his letter Mr Bevan decries Australia not having a headline company tax rate below 30 pe rcent – suggesting the abolition of imputation would permit this to happen. But as Mr Bevan obviously fails to understand, the effective rate of company taxation for the great majority of shareholders is zero. It is zero because the commonwealth returns the full company tax to shareholders whenever dividends are paid. And when I went to school, zero beats 30 percent, or 25 percent, or any number below that as a rate of taxation.

Mr Bevan gives his hand away when he writes that in 1987 the ASX "was owned mostly by individuals and family companies", where today "the ASX is owned by superannuation funds". Mr Bevan apparently believes superannuation funds are populated by Martians.

In 1987, the great majority of Australians had no access whatsoever to the great wealth machinery of public markets. Let alone compound earnings.

Your correspondent is urging a return to those days when only a narrow group of reasonably wealthy people, family companies and institutions had access to stock markets. And he thinks this would represent a reform.

The distortion in the Australian taxation system is not dividend imputation as Mr Bevan suggests, but rather the final rate of tax on company income – the top rate of personal taxation. At 47 per cent, this is way too high; indeed a gap of 17 percentage points above the company tax rate. This is where any distortion lies.

In 1987 I took the double tax monkey off the back of every shareholder. You would have to be a weirdo or pain seeker to argue that this extra level of company taxation should be reimposed.

Paul Keating

Potts Point, NSW

 

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